Annex 1 – Details of Economic and Fiscal Projections

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Economic Projections—Average Private Sector Forecasts

The average of private sector forecasts has been used as the basis for fiscal planning since 1994 and introduces an element of independence into the government’s fiscal forecast. This practice has been supported by international organizations such as the International Monetary Fund.

The Department of Finance Canada regularly surveys private sector economists on their views on the outlook for the Canadian economy. The economic forecast presented in this section is based on a survey conducted in September 2016.

The September 2016 survey includes the views of 14 private sector economists:

• BMO Capital Markets,
• Caisse de dépôt et placement du Québec,
• Canadian Federation of Independent Business,
• CIBC World Markets,
• The Conference Board of Canada,
• Desjardins,
• IHS Global Insight,
• Industrial Alliance Insurance and Financial Services Inc.,
• Laurentian Bank Securities,
• National Bank Financial Markets,
• Royal Bank of Canada,
• Scotiabank,
• TD Bank Financial Group, and
• the University of Toronto (Policy and Economic Analysis Program).

Since the release of Budget 2016, the average private sector outlook has been revised down. For 2016 as a whole, private sector economists now expect real gross domestic product (GDP) growth of 1.2 per cent, lower than the 1.4 per cent forecast in Budget 2016 (this masks considerable unevenness in the quarterly pattern of growth, in particular the 1.6 per cent contraction in output in the second quarter—related to the Fort McMurray wildfires—and an expected 3.4 per cent rebound in output in the third quarter, as these effects unwind). Furthermore, real GDP growth in 2017 and beyond is, on average, 0.2 percentage points lower than expected in Budget 2016 (Table A1.1).

Private sector economists assume West Texas Intermediate (WTI) crude oil prices will rise slightly more gradually than in Budget 2016, reaching US$60 per barrel in 2020, compared to US$63 per barrel in Budget 2016.

The outlook for GDP inflation (the broadest measure of economy-wide price inflation) for 2016 in the September survey is 0.3 percentage points lower than expected in Budget 2016. It is also revised down by 0.1 percentage points on average in the remaining years of the forecast horizon, reflecting slightly lower Consumer Price Index inflation and crude oil prices.

As a result of these developments, nominal GDP growth in the September survey of private sector economists is expected to be 1.8 per cent in 2016 (compared with expectations of 2.3 per cent in Budget 2016), and about 4.0 per cent on average over the following years, 0.3 percentage points lower than Budget 2016.

Also, economists have again revised down their expectations for both short- and long-term interest rates over the medium term relative to Budget 2016 (on average by 50 basis points for short-term rates and 80 basis points for long-term rates), reflecting weaker-than-expected economic developments. This downward revision to long-term rates has significant impacts on the valuation of the government’s pension and benefits liabilities, which are, in part, discounted using the Government of Canada long-term bond rate, as well as interest charges on the government’s debt.

Finally, consistent with the weak economic results in the United States in the first half of the year, private sector economists expect a modest increase of 1.6 per cent in U.S. real GDP in 2016 as a whole, 0.7 percentage points lower than the Budget 2016 forecast. U.S. real GDP growth is projected to pick up to around 2.0 per cent over the remainder of the forecast horizon, again noticeably lower than the Budget 2016 average forecast for that period (2.3 per cent).

Fiscal Projections

The remainder of this annex reviews the major economic and fiscal developments since Budget 2016 and updates the government’s fiscal projections for the 2016–17 to 2021–22 period.

Changes in the fiscal outlook since Budget 2016 are shown in Table A1.2.

Impact of Economic and Fiscal Developments

Relative to Budget 2016, projected budgetary revenues are lower over the forecast horizon, as the carry-forward of better-than-expected results in 2015–16 is more than offset by the lower projections for nominal GDP and lower projected interest rates, which negatively impact the expected rate of return on interest-bearing assets, recorded as part of other revenues. 

Income tax revenue is projected to be lower than in Budget 2016 due to weaker economic growth (lower wages and salaries and corporate profits) negatively affecting both personal income tax (PIT) and corporate income tax revenues. The better-than-expected outcome for income tax revenue in 2015–16 was in large part due to the tax planning behaviour of individuals to recognize income in the 2015 tax year before the new 33 per cent tax rate came into effect in 2016. This reduces the outlook for PIT revenues in 2016–17 and future years.

Sales and excise taxes are lower largely as a result of the weaker outlook for nominal GDP.

Employment Insurance (EI) premium revenues are higher over the forecast horizon due to higher projected EI benefits, which lead to an increase in the projected seven-year break-even rate from $1.61 to $1.66 per $100 of insurable earnings relative to Budget 2016. Of note, the increase in EI premium revenues has no net impact on the budgetary balance over time, as it is offset by higher projected EI benefit expenses resulting from the weaker economic outlook.

Other revenues, such as those resulting from loans and investments, interest and penalties, enterprise Crown corporations’ profits and assets held in the Exchange Fund Account, are lower in all years of the forecast horizon largely as a result of the downward revisions to projected interest rates.

With respect to expenses, major transfers to persons are projected to be lower in 2016–17 than projected in Budget 2016 as a result of the carry-forward of better-than-expected 2015–16 results. Major transfers to persons are projected to be higher over the remainder of the forecast horizon as the weaker economic outlook leads to projected increases in EI and Old Age Security benefits and the Canada Child Benefit (CCB). In addition, the decision to index the CCB to inflation beginning in 2020 raises the benefit relative to the budget projection starting in 2020–21.

Major transfers to other levels of government are broadly unchanged in the near term, but are lower than Budget 2016 projections in the later years of the forecast due to the weaker outlook for nominal GDP growth, to which the Canada Health Transfer and Equalization are pegged.

Compared to Budget 2016, direct program expenses are projected to remain largely unchanged in 2016–17 but are projected to be higher over the remainder of the forecast horizon. This is largely as a result of higher projected expenses associated with employee future benefits, which are sensitive to changes in projected interest rates, as well as measures announced since Budget 2016, including those announced in this Fall Economic Statement. The impact of changing interest rates on employee future benefits is discussed in greater detail in the box below.

Public debt charges are expected to be lower than projected in Budget 2016 due largely to lower projected interest rates. 

Summary Statement of Transactions

Table A1.3 summarizes the government’s projected financial position over the forecast horizon. These projections are based on the average private sector forecast for the economy discussed above.

The budgetary balance is expected to show deficits of $25.1 billion in 2016–17 and $27.8 billion in 2017–18. Over the remainder of the forecast horizon, deficits are expected to decline significantly from $25.9 billion in 2018–19 to $14.6 billion in 2021–22. The federal debt-to-GDP ratio is projected to decline gradually after 2018–19 to the end of the fiscal horizon, reaching 30.4 per cent in 2021–22. This outlook includes new policy actions taken since Budget 2016 and the new measures announced in this Fall Economic Statement.

Policy Actions Taken Since Budget 2016

Setting a new bar for transparency, Table A1.4 summarizes the policy actions taken since Budget 2016 and up to this Fall Economic Statement. Altogether these measures are expected to reduce the budgetary balance by $7.7 billion over six years, on a net basis, starting in 2016–17.

Outlook for Budgetary Revenues

Table A1.5 sets out the government’s projection for budgetary revenues. Overall, budgetary revenues are expected to decrease by 1.5 per cent in 2016–17, reflecting lower personal income tax revenues and other revenues, including those of Crown corporations. Over the remainder of the forecast horizon, revenues are projected to grow at an average annual rate of 4.1 per cent, roughly in line with projected growth in nominal GDP.

Personal income tax revenues—the largest component of budgetary revenues—are projected to decrease by $1.2 billion, or 0.8 per cent, to $143.7 billion in 2016–17. The reduction in 2016–17 largely reflects the impact of tax planning by high-income individuals to recognize income in the 2015 tax year before the new 33 per cent tax rate came into effect in 2016. This behaviour raised revenues in 2015–16 but will lower them in 2016–17. Over the remainder of the projection period, personal income tax revenues are forecast to increase faster than growth in nominal GDP, averaging 4.7 per cent annually, reflecting the progressive nature of the income tax system combined with projected real income gains.

Corporate income tax revenues are projected to remain unchanged at $41.4 billion in 2016–17 due to weak corporate profits. Over the remainder of the projection period, corporate income tax revenues are projected to grow at an average annual rate of 3.2 per cent, less than the rate of growth in nominal GDP, reflecting the use of loss carry-forwards and the projected outlook for profit growth.

Non-resident income tax revenues are income taxes paid by non-residents on Canadian-sourced income, notably dividends and interest payments. For 2016–17, non-resident income tax revenues are projected to decline by $0.2 billion, or 3.1 per cent, in line with year-to-date results. Over the remainder of the forecast horizon, they are projected to grow at an average annual rate of 3.9 per cent, in line with projected growth in dividends, interest payments and profits.

Goods and Services Tax (GST) revenues are forecast to grow by 1.7 per cent in 2016–17 based on projected growth in taxable consumption and year-to-date results. Over the remainder of the projection period, GST revenues are forecast to grow by 3.9 per cent per year on average, based on projected growth in taxable consumption and in the Goods and Services Tax/Harmonized Sales Tax Credit.

Customs import duties are projected to decline by 4.4 per cent in 2016–17, and 11.3 per cent in 2017–18 reflecting the planned introduction of the Canada-European Union Comprehensive Economic and Trade Agreement and the potential introduction of the Trans-Pacific Partnership. Over the remaining projection horizon, annual growth in customs import duties is projected to average 2.2 per cent based on projected growth in imports.

Other excise taxes and duties are projected to increase by 0.8 per cent in 2016–17, consistent with year-to-date results. Over the remainder of the projection horizon, other excise taxes and duties are expected to grow at an average annual rate of 0.5 per cent based on historical consumption trends.

EI premium revenues are projected to decline by 3.1 per cent in 2016–17 and by 5.0 per cent in 2017–18 due to the introduction of the seven-year break-even rate mechanism in 2017. This new rate-setting mechanism ensures that EI premiums are no higher than needed to pay for the EI program over time. Based on the new EI rate-setting process, the EI premium rate for 2017 has been set to $1.63 per $100 of insurable earnings, which represents a significant decline from the 2016 rate of $1.88 per $100 of insurable earnings. The seven-year break-even rate for 2018 has been estimated at $1.66 per $100 of insurable earnings. For fiscal planning purposes, an EI premium rate of $1.66 has been applied over the remainder of the projection horizon (see Employment Insurance Operating Account box), such that the EI Operating Account achieves cumulative balance by 2024. EI premium revenues are expected to resume their upward trend in 2018–19 based on projected growth in wages and salaries.

Other revenues are made up of three broad components: Crown corporation revenues from consolidated Crown corporations and net income from enterprise Crown corporations; other program revenues from returns on investments, proceeds from the sales of goods and services, and other miscellaneous revenues; and revenues in the Exchange Fund Account.

Crown corporation revenues tend to be volatile, owing to the net gains or losses from enterprise Crown corporations and the impact of returns on Crown borrowings. For example, in 2015–16, a one-time fiscal gain of $2.1 billion was realized on the sale of the government’s remaining holdings of General Motors common shares by the Canada Development Investment Corporation. In 2016–17, Crown corporation revenues are projected to decline by 18.6 per cent, due in large part to that gain. Over the remainder of the forecast horizon, Crown corporation revenues are projected to grow at an average annual rate of 5.6 per cent, primarily due to the outlooks presented in respective corporate plans.

Other program revenues are affected by interest rate movements, exchange rate movements (which affect the Canadian-dollar value of foreign-denominated assets) and flow-through items that give rise to an offsetting expense and therefore do not impact the budgetary balance. These revenues are projected to increase by $0.3 billion, or 2.2 per cent, in 2016–17. Over the remainder of the projection period, other program revenues are projected to increase at an average annual rate of 5.0 per cent, largely as a result of the projected increase in interest rates.

Net foreign exchange revenues, which consist mainly of returns on investments held in the Exchange Fund Account, are volatile and sensitive to fluctuations in foreign exchange rates and foreign interest rates. These revenues are expected to decrease in 2016–17, due in large part to significant one-time gains on the sale of investments in the Exchange Fund Account in 2015–16, which are not expected to recur. Over the remainder of the projection period, net foreign exchange revenues are projected to grow at an average annual rate of 13.6 per cent, reflecting a projected increase in interest rates and the anticipated appreciation in the Canadian dollar by private sector forecasters.

Outlook for Program Expenses

Table A1.6 provides an overview of the projections for program expenses by major component. Program expenses consist of major transfers to persons, major transfers to other levels of government and direct program expenses.

Major transfers to persons are projected to increase from $91.2 billion in 2016–17 to $109.8 billion in 2021–22. Major transfers to persons consist of elderly, EI and children’s benefits.

Elderly benefits, which are comprised of Old Age Security, Guaranteed Income Supplement and Allowance payments to qualifying seniors, are projected to grow from $48.4 billion in 2016–17 to $63.9 billion in 2021–22, or approximately 5.7 per cent per year. The expected increase in elderly benefits is due to projected consumer price inflation, to which benefits are fully indexed, a projected increase in the seniors’ population, and the increase in the Guaranteed Income Supplement for single seniors announced in Budget 2016.

EI benefits are projected to increase by 8.2 per cent to $21.0 billion in 2016–17. This growth is in line with year-to-date results and the roll-out of EI benefit measures announced in Budget 2016. Over the remainder of the projection period, EI benefits are projected to grow moderately, averaging 1.7 per cent annually as gains in average weekly benefits are largely offset by the expected improvement in the labour market.

Children’s benefits are projected to rise from $21.8 billion in 2016–17 to $23.1 billion in 2021–22, reflecting the new Canada Child Benefit, which replaced the Canada Child Tax Benefit and the Universal Child Care Benefit as of July 2016. Stronger growth in the final two years of the projection period is due to the indexation of the benefit beginning in 2020–21.

Major transfers to other levels of government, which include the Canada Health Transfer (CHT), the Canada Social Transfer (CST), Equalization, Territorial Formula Financing and the Gas Tax Fund, among others, are expected to increase over the forecast horizon, from $68.5 billion in 2016–17 to $80.2 billion in 2021–22.

The CHT is projected to grow from $36.1 billion in 2016–17 to $43.1 billion in 2021–22. Starting in 2017–18, the CHT will grow in line with a three-year moving average of nominal GDP growth, with funding guaranteed to increase by at least 3.0 per cent per year. The CST is legislated to grow at 3.0 per cent per year. Gas Tax Fund payments are indexed at 2.0 per cent per year, with increases applied in $100 million increments.

Direct program expenses are projected to rise to $131.6 billion in 2016–17 and further to $146.5 billion in 2021–22, reflecting in part measures announced in Budget 2016 and in this Fall Economic Statement. Direct program expenses include operating expenses, transfer payments administered by departments and capital amortization.

The projected increase in direct program expenses is driven by an increase in transfer payments administered by departments, including transfers to provincial, municipal and Aboriginal governments and post-secondary institutions for investment in infrastructure, as well as funding for education. Overall, transfer payments are projected to increase from $41.7 billion in 2016–17 to $48.9 billion in 2021–22.

Operating expenses reflect the cost of doing business for more than 100 government departments and agencies. Operating expenses are projected to increase from $84.6 billion in 2016–17 to $90.9 billion in 2021–22 due in part to measures announced in Budget 2016 and this Fall Economic Statement.

Capital amortization is expected to increase from $5.4 billion in 2016–17 to $6.7 billion in 2021–22 as a result of recent and planned investments and upgrades to existing federal capital.

Risks to the Fiscal Projections

Risks associated with the economic outlook are the greatest source of uncertainty for fiscal projections. To help quantify these risks in respect of their impact on the fiscal outlook, tables illustrating the sensitivity of the budgetary balance to a number of economic shocks are provided below.

Besides the economic outlook, there are other unique sources of upside or downside risks to the fiscal projections, such as the volatility in the relationships between fiscal variables and the underlying activities to which they relate. For example, relationships between personal income taxes and personal income or the extent to which departments and agencies do not fully use all of the resources appropriated by Parliament can fluctuate for reasons not directly linked to economic variables. These fluctuations introduce an additional level of uncertainty for fiscal projections.

Sensitivity of the Budgetary Balance to Economic Shocks

Changes in economic assumptions affect the projections for revenues and expenses. The following tables illustrate the sensitivity of the budgetary balance to a number of economic shocks:

• A one-year, 1-percentage-point decrease in real GDP growth driven equally by lower productivity and employment growth.
• A decrease in nominal GDP growth resulting solely from a one-year, 1-percentage-point decrease in the rate of GDP inflation (assuming that the Consumer Price Index moves in line with GDP inflation).
• A sustained 100-basis-point increase in all interest rates.

These sensitivities are generalized rules of thumb that assume any decrease in economic activity is proportional across income and expenditure components, and are meant to provide a broad illustration of the impact of economic shocks on the outlook for the budgetary balance. Actual economic shocks may have different fiscal impacts. For example, they may be concentrated in specific sectors of the economy or cause different responses in key economic variables (e.g. GDP inflation and Consumer Price Index inflation may have different responses to a given shock).

A 1-percentage-point decrease in real GDP growth proportional across income and expenditure components reduces the budgetary balance by $4.6 billion in the first year, $4.3 billion in the second year and $4.3 billion in the fifth year (Table A1.7).

• Tax revenues from all sources fall by a total of $4.0 billion in the first year and by $4.0 billion in the second year. Personal income tax revenues decrease as employment and the underlying tax base fall. Corporate income tax revenues fall as output and profits decrease. GST revenues decrease as a result of lower consumer spending associated with the fall in employment and personal income.
• EI premium revenues increase as a result of an increase in the EI premium rate, which, under the seven-year break-even mechanism, adjusts to offset the increase in benefits due to the higher number of unemployed, such that the EI Operating Account balances over time.
• Expenses rise, mainly reflecting higher EI benefits (due to an increase in the number of unemployed) and higher public debt charges (reflecting a higher stock of debt due to the lower budgetary balance). This rise is partially offset by lower other program expenses (as certain programs are tied directly to growth in nominal GDP).

A 1-percentage-point decrease in nominal GDP growth proportional across income and expenditure components resulting solely from lower GDP inflation (assuming that the Consumer Price Index moves in line with GDP inflation) lowers the budgetary balance by $2.0 billion in the first year, $1.8 billion in the second year and $1.3 billion in the fifth year (Table A1.8).

• Lower prices result in lower nominal income and, as a result, personal income tax revenues decrease, reflecting declines in the underlying nominal tax base. As the parameters of the personal income tax system are indexed to inflation and automatically adjust in response to the shock, the fiscal impact is smaller than under the real shock. For the other sources of tax revenue, the negative impacts are similar under the real and nominal GDP shocks.
• EI premium revenues decrease in response to lower earnings.
• Other revenues decline slightly as lower prices lead to lower revenues from the sales of goods and services.
• Partly offsetting lower revenues are the declines in the cost of statutory programs that are indexed to inflation, such as elderly benefit payments, and downward pressure on federal program expenses. Payments under these programs are smaller if inflation is lower. In addition, other program expenses are also lower as certain programs are tied directly to growth in wages and nominal GDP.
• Public debt charges decline in the first year due to lower costs associated with Real Return Bonds, then rise due to the higher stock of debt.

An increase in interest rates decreases the budgetary balance by $1.0 billion in the first year, $2.0 billion in the second year and $3.4 billion in the fifth year (Table A1.9). The decline stems entirely from increased expenses associated with public debt charges. The impact on debt charges rises through time as longer-term debt matures and is refinanced at higher rates. Moderating the overall impact is an increase in revenues associated with the increase in the rate of return on the government’s interest-bearing assets, which are recorded as part of other revenues. The impacts of changes in interest rates on public sector pension and benefit expenses are excluded from the sensitivity analysis.

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